There are reasons to be positive for sustainable stocks in 2023. Areas such as decarbonisation, resource efficiency and healthcare innovation remain powerful growth drivers, highlighting the long-term earnings potential of companies in a sustainable stocks portfolio.
This has been a tough year for sustainable equities. After two years of extraordinary returns, a combination of increasing interest rates which has pressured valuations of higher-quality stock and the war in Ukraine sending oil prices and energy stocks soaring had made 2022 challenging for sustainable stocks. However, we see reasons to be more positive going into 2023.
Whilst fluctuations in valuation and sentiment drive short-term returns, company earnings matter far more for long-term returns, and this is where we choose to focus our efforts. The five key themes the fund is invested in (clean energy, financial inclusion, health care innovation, improving resource intensity, and infrastructure decarbonisation) remain as powerful growth drivers as ever, giving us great confidence in the long-term earnings potential of the companies we invest in. It is important not to lose sight of these powerful structural drivers in times of higher volatility, like we see today.
What could surprise markets in 2023?
One risk we are paying close attention to for 2023 is labour availability and wage inflation. The labour market has proved much tighter than most expected this year, which has translated into higher wage inflation and lower profit margins for employers. Although announcements of hiring freezes or layoffs are now (sadly) a daily event, without a significant improvement in labour availability next year, we think persistent labour inflation could cause margins to surprise negatively in 2023.
The silver lining here is that the best way to tackle labour availability and cost is by investing in productivity. We think companies have been under-investing for decades, with capex and R&D spending falling from 70% of cash use in 1990 to 40% today, contributing to the problem we find ourselves in today. While the market expects companies to tighten their belts on capital spending into 2023, we think that capital expenditure could surprise positively, particularly in areas that relate to efficiency, such as robotics and automation. The reshoring trend, as companies localise supply chains, also boosts the prospects of higher capital spending over the coming years.
Share of total S&P 500 cash use - Companies now spend the most on buybacks and dividends
Source: Compustat, Goldman Sachs Global Investment Research, 26 October 2022.
We expect the pressures of higher inflation and interest rates to weigh on the more cyclical areas of growth and we are therefore shifting the fund’s exposure to more secular growth areas which we expect to perform better in 2023. For example, we have reduced exposure to areas such as US housing, which will likely suffer from a sharp slowdown in demand as mortgage costs rise. The good news is that we see a number of end-markets with an improving growth outlook - something that will likely be in short supply in 2023. The recently enacted Inflation Reduction Act in the US will spark significant growth in decarbonisation investments in the US, to which the fund has significant exposure through stocks such as Quanta Services, SolarEdge and Orsted.
